Demand and Supply Model

Demand and Supply Model Outline

  • Market: Focus on a perfectly competitive market.

  • Demand:

    • Definition of demand.

    • Law of demand.

    • Demand curve and function.

    • Change in demand.

    • Factors that shift the demand curve.

  • Supply:

    • Definition of supply.

    • Law of supply.

    • Supply curve and function.

    • Change in supply.

    • Factors that shift the supply curve.

  • Equilibrium:

    • Impact of factor changes on equilibrium price and quantity.

Supply Definition

  • Supply: Represents the relationship between price and quantity supplied of a particular good, other things equal (ceteris paribus).

  • Quantity Supplied: The specific amount of a good that sellers are willing and able to sell at a given price.

  • Supply Schedule: A table that illustrates the quantity supplied at various prices.

  • Supply Curve: A graphical representation of the supply schedule.

    • Price is plotted on the vertical (yy) axis.

    • Quantity (supplied) is plotted on the horizontal (xx) axis.

Supply Schedule and Supply Curve Example

  • Example (Ice-cream Cones):

    • Price of Ice-cream Cone ()</strong>∣<strong>QuantityOfConesSupplied</strong></p></li><li><p>)</strong> | <strong>Quantity Of Cones Supplied</strong></p></li><li><p>0.00∣|0cones</p></li><li><p>cones</p></li><li><p>0.50∣|0cones</p></li><li><p>cones</p></li><li><p>1.00∣|1cone</p></li><li><p>cone</p></li><li><p>1.50∣|2cones</p></li><li><p>cones</p></li><li><p>2.00∣|3cones</p></li><li><p>cones</p></li><li><p>2.50∣|4cones</p></li><li><p>cones</p></li><li><p>3.00∣|5cones</p></li></ul></li><li><p><strong>Characteristic:</strong>Thesupplycurveslopesupwardbecauseahigherpriceincreasesthequantitysupplied.Thisreflectsthepositiverelationshipbetweenpriceandquantitysupplied.</p></li></ul><h3id="f62a2e4c−c53a−4a7b−a43a−f9d117392d21"data−toc−id="f62a2e4c−c53a−4a7b−a43a−f9d117392d21"collapsed="false"seolevelmigrated="true">LawofSupply</h3><ul><li><p><strong>Principle:</strong><em>Otherthingsequal</em>(ceterisparibus):</p><ul><li><p>Whenthepriceofagoodrises,thequantitysuppliedofthegoodincreases.</p></li><li><p>Whenthepriceofagoodfalls,thequantitysuppliedofthegooddecreases.</p></li></ul></li><li><p><strong>Relationship:</strong>Priceandquantitysuppliedarepositivelyordirectlyrelated.</p></li></ul><h3id="c47a8620−f2b3−4542−9c03−004b06e593ab"data−toc−id="c47a8620−f2b3−4542−9c03−004b06e593ab"collapsed="false"seolevelmigrated="true">FactorsthatShiftSupply</h3><ul><li><p>Thesefactorscausetheentiresupplycurvetoshifteithertotheleft(decreaseinsupply)ortotheright(increaseinsupply).</p></li></ul><h4id="2c88f04e−65c9−45aa−ac31−9bd4b304abeb"data−toc−id="2c88f04e−65c9−45aa−ac31−9bd4b304abeb"collapsed="false"seolevelmigrated="true">1.NumberofSellers(Producers)</h4><ul><li><p><strong>IncreaseinSellers:</strong>Ifmoresellersenterthemarket,marketsupplyincreases(supplycurveshiftsright).</p></li><li><p><strong>DecreaseinSellers:</strong>Ifthenumberofsellersdeclines,marketsupplydecreases(supplycurveshiftsleft).</p></li></ul><h4id="3a9bc4cf−fbef−4a0e−8724−b99e7e8924de"data−toc−id="3a9bc4cf−fbef−4a0e−8724−b99e7e8924de"collapsed="false"seolevelmigrated="true">2.InputPrices</h4><ul><li><p><strong>Definition:</strong>Inputpricesincludecostslikewagesforworkersandrawmaterials.</p></li><li><p><strong>IncreaseinInputPrice:</strong>Otherthingsconstant,anincreaseinthecostofaninputleadstoadecreaseinsupply(supplycurveshiftsleft).</p><ul><li><p><strong>Example:</strong>Ifthepriceofoil,animportantinputformanyindustries,increases,thesupplyofgoodsfromthoseindustrieswilldecrease.</p></li></ul></li><li><p><strong>DecreaseinInputPrice:</strong>Adecreaseinthecostofaninputleadstoanincreaseinsupply(supplycurveshiftsright).</p></li></ul><h4id="ead69131−9621−48d1−8c42−34572fce6459"data−toc−id="ead69131−9621−48d1−8c42−34572fce6459"collapsed="false"seolevelmigrated="true">3.PricesofRelatedGoodsinProduction</h4><ul><li><p>Thisreferstogoodsthatcanbeproducedusingthesameresourcesorareproducedtogether.</p></li><li><p><strong>SubstitutesinProduction:</strong></p><ul><li><p><strong>Definition:</strong>IfthesameresourcescanbeusedtoproduceeithergoodAorgoodB.</p></li><li><p><strong>Effect:</strong>WhenthepriceofgoodAincreases,producersmayshiftresourcestoproducemoreofA,leadingtoadecreaseinthesupplyofgoodB(supplycurveofBshiftsleft).</p></li></ul></li><li><p><strong>ComplementsinProduction:</strong></p><ul><li><p><strong>Definition:</strong>Iftwogoods(CandD)mustbeproducedtogether.</p></li><li><p><strong>Example:</strong>Crudeoilandnaturalgasareoftencomplementsinproduction.</p></li><li><p><strong>Effect:</strong>AnincreaseinthepriceofgoodCleadstoanincreaseintheproductionofC,whichsimultaneouslyincreasesthesupplyforgoodD(supplycurveofDshiftsright).</p></li></ul></li></ul><h4id="21a11893−312b−41f6−b9e1−2de63d7bf0d1"data−toc−id="21a11893−312b−41f6−b9e1−2de63d7bf0d1"collapsed="false"seolevelmigrated="true">4.TechnologyImprovements</h4><ul><li><p><strong>Effect:</strong>Advancesintechnologygenerallymakeproductionmoreefficient,increasingsupply(supplycurveshiftsright).</p></li></ul><h4id="419fe987−1d1f−4222−ac4f−447b8f3b6d5e"data−toc−id="419fe987−1d1f−4222−ac4f−447b8f3b6d5e"collapsed="false"seolevelmigrated="true">5.Expectations</h4><ul><li><p><strong>ExpectedFuturePrices:</strong></p><ul><li><p><strong>HigherExpectedPrices:</strong>Ifsellersexpecthigherpricesinthefuture,theymaydecreasecurrentsupplytoholdinventoryforlatersale(supplycurveshiftsleft).</p></li><li><p><strong>LowerExpectedPrices:</strong>Ifsellersexpectlowerpricesinthefuture,theymayincreasecurrentsupplytosellbeforepricesdrop(supplycurveshiftsright).</p></li></ul></li></ul><h3id="848645b7−8541−411f−a8b0−e217523b7cc6"data−toc−id="848645b7−8541−411f−a8b0−e217523b7cc6"collapsed="false"seolevelmigrated="true">Summary:MovementAlongvs.ShiftoftheSupplyCurve</h3><ul><li><p><strong>MovementAlongtheSupplyCurve:</strong>Occursduetoachangeinthe<em>priceofthegooditself</em>.</p></li><li><p><strong>ShiftoftheSupplyCurve:</strong>Occursduetoachangeinanyofthefollowingvariables:</p><ul><li><p>Numberofsellers</p></li><li><p>Pricesofrelatedgoodsinproduction</p></li><li><p>Inputprices</p></li><li><p>Expectations</p></li><li><p>Technologyimprovement</p></li></ul></li></ul><h3id="4254c6c5−28da−4345−819f−22ec45d97a7b"data−toc−id="4254c6c5−28da−4345−819f−22ec45d97a7b"collapsed="false"seolevelmigrated="true">SupplyFunctionExample</h3><ul><li><p><strong>Question:</strong>Giventwoequations:cones</p></li></ul></li><li><p><strong>Characteristic:</strong> The supply curve slopes upward because a higher price increases the quantity supplied. This reflects the positive relationship between price and quantity supplied.</p></li></ul><h3 id="f62a2e4c-c53a-4a7b-a43a-f9d117392d21" data-toc-id="f62a2e4c-c53a-4a7b-a43a-f9d117392d21" collapsed="false" seolevelmigrated="true">Law of Supply</h3><ul><li><p><strong>Principle:</strong> <em>Other things equal</em> (ceteris paribus):</p><ul><li><p>When the price of a good rises, the quantity supplied of the good increases.</p></li><li><p>When the price of a good falls, the quantity supplied of the good decreases.</p></li></ul></li><li><p><strong>Relationship:</strong> Price and quantity supplied are positively or directly related.</p></li></ul><h3 id="c47a8620-f2b3-4542-9c03-004b06e593ab" data-toc-id="c47a8620-f2b3-4542-9c03-004b06e593ab" collapsed="false" seolevelmigrated="true">Factors that Shift Supply</h3><ul><li><p>These factors cause the entire supply curve to shift either to the left (decrease in supply) or to the right (increase in supply).</p></li></ul><h4 id="2c88f04e-65c9-45aa-ac31-9bd4b304abeb" data-toc-id="2c88f04e-65c9-45aa-ac31-9bd4b304abeb" collapsed="false" seolevelmigrated="true">1. Number of Sellers (Producers)</h4><ul><li><p><strong>Increase in Sellers:</strong> If more sellers enter the market, market supply increases (supply curve shifts right).</p></li><li><p><strong>Decrease in Sellers:</strong> If the number of sellers declines, market supply decreases (supply curve shifts left).</p></li></ul><h4 id="3a9bc4cf-fbef-4a0e-8724-b99e7e8924de" data-toc-id="3a9bc4cf-fbef-4a0e-8724-b99e7e8924de" collapsed="false" seolevelmigrated="true">2. Input Prices</h4><ul><li><p><strong>Definition:</strong> Input prices include costs like wages for workers and raw materials.</p></li><li><p><strong>Increase in Input Price:</strong> Other things constant, an increase in the cost of an input leads to a decrease in supply (supply curve shifts left).</p><ul><li><p><strong>Example:</strong> If the price of oil, an important input for many industries, increases, the supply of goods from those industries will decrease.</p></li></ul></li><li><p><strong>Decrease in Input Price:</strong> A decrease in the cost of an input leads to an increase in supply (supply curve shifts right).</p></li></ul><h4 id="ead69131-9621-48d1-8c42-34572fce6459" data-toc-id="ead69131-9621-48d1-8c42-34572fce6459" collapsed="false" seolevelmigrated="true">3. Prices of Related Goods in Production</h4><ul><li><p>This refers to goods that can be produced using the same resources or are produced together.</p></li><li><p><strong>Substitutes in Production:</strong></p><ul><li><p><strong>Definition:</strong> If the same resources can be used to produce either good A or good B.</p></li><li><p><strong>Effect:</strong> When the price of good A increases, producers may shift resources to produce more of A, leading to a decrease in the supply of good B (supply curve of B shifts left).</p></li></ul></li><li><p><strong>Complements in Production:</strong></p><ul><li><p><strong>Definition:</strong> If two goods (C and D) must be produced together.</p></li><li><p><strong>Example:</strong> Crude oil and natural gas are often complements in production.</p></li><li><p><strong>Effect:</strong> An increase in the price of good C leads to an increase in the production of C, which simultaneously increases the supply for good D (supply curve of D shifts right).</p></li></ul></li></ul><h4 id="21a11893-312b-41f6-b9e1-2de63d7bf0d1" data-toc-id="21a11893-312b-41f6-b9e1-2de63d7bf0d1" collapsed="false" seolevelmigrated="true">4. Technology Improvements</h4><ul><li><p><strong>Effect:</strong> Advances in technology generally make production more efficient, increasing supply (supply curve shifts right).</p></li></ul><h4 id="419fe987-1d1f-4222-ac4f-447b8f3b6d5e" data-toc-id="419fe987-1d1f-4222-ac4f-447b8f3b6d5e" collapsed="false" seolevelmigrated="true">5. Expectations</h4><ul><li><p><strong>Expected Future Prices:</strong></p><ul><li><p><strong>Higher Expected Prices:</strong> If sellers expect higher prices in the future, they may decrease current supply to hold inventory for later sale (supply curve shifts left).</p></li><li><p><strong>Lower Expected Prices:</strong> If sellers expect lower prices in the future, they may increase current supply to sell before prices drop (supply curve shifts right).</p></li></ul></li></ul><h3 id="848645b7-8541-411f-a8b0-e217523b7cc6" data-toc-id="848645b7-8541-411f-a8b0-e217523b7cc6" collapsed="false" seolevelmigrated="true">Summary: Movement Along vs. Shift of the Supply Curve</h3><ul><li><p><strong>Movement Along the Supply Curve:</strong> Occurs due to a change in the <em>price of the good itself</em>.</p></li><li><p><strong>Shift of the Supply Curve:</strong> Occurs due to a change in any of the following variables:</p><ul><li><p>Number of sellers</p></li><li><p>Prices of related goods in production</p></li><li><p>Input prices</p></li><li><p>Expectations</p></li><li><p>Technology improvement</p></li></ul></li></ul><h3 id="4254c6c5-28da-4345-819f-22ec45d97a7b" data-toc-id="4254c6c5-28da-4345-819f-22ec45d97a7b" collapsed="false" seolevelmigrated="true">Supply Function Example</h3><ul><li><p><strong>Question:</strong> Given two equations:P = 2500 - 0.25 Q(1)and(1) andP = 1200 + 0.33 Q(2).Whichcouldrepresentasupplyfunction?</p></li><li><p><strong>Answer:</strong>Equation(2)couldrepresentasupplyfunction.</p></li><li><p><strong>Reasoning:</strong>Asupplyfunctionmustdemonstrateapositive(direct)relationshipbetweenprice((2). Which could represent a supply function?</p></li><li><p><strong>Answer:</strong> Equation (2) could represent a supply function.</p></li><li><p><strong>Reasoning:</strong> A supply function must demonstrate a positive (direct) relationship between price (P)andquantitysupplied() and quantity supplied (Q),asstatedbytheLawofSupply.Inequation(2),thecoefficientof), as stated by the Law of Supply. In equation (2), the coefficient ofQ((0.33)ispositive,indicatingthatasquantityincreases,pricealsoincreases,consistentwithanupward−slopingsupplycurve.Equation(1)showsanegativecoefficient() is positive, indicating that as quantity increases, price also increases, consistent with an upward-sloping supply curve. Equation (1) shows a negative coefficient (-0.25$$), which would represent a demand function (inverse relationship).

    Core Concepts Illustrated by Practice Questions

    • Relationship between Quantity Supplied and Price: This relationship is direct or positive.

    • Law of Supply Implications: Producers are willing to offer more of a product at higher prices than at lower prices.

    • Upward Slope of the Supply Curve: Directly reflects the Law of Supply, indicating that price and quantity supplied are positively related.

    • Factors Causing a Leftward Shift in Supply (Decrease in Supply): Examples include some firms leaving an industry (fewer sellers), an increase in input prices, or negative technological advancements (or no improvement).

    • Factors Causing a Rightward Shift in Supply (Increase in Supply): Examples include an improvement in production technology, a decline in needed input prices, or an increase in the number of firms.

    • Consequences of a Supply Decrease: If supply decreases (e.g., due to unseasonably cold weather affecting crops), it means the amount of the good available at various prices has declined.

    • Defining a Decrease in Supply: Occurs when producers require higher prices than before to produce a given level of output (or are willing to supply less at any given price).

    • Variables Constant Along a Supply Curve: When moving along a supply curve, the only variable changing is the price of the product itself. Other factors, such as the number of firms, expectations about future prices, and production techniques, are held constant (ceteris paribus) and would cause the curve to shift if they changed.